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Principal of Accounting and Great Financing Report (Assessment)

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Updated: May 4th, 2022

Expenses should be summed to the cost basis of a fixed asset on a company’s balance sheet. Fixed assets and building costs should be capitalised. Rather than capitalizing them in their respective period in which they were incurred, capitalized costs have to be recognized over longer periods. This may be done through depreciation or amortization. Capitalizing costs must follow the Matching Principle of accounting. The principal aims at matching expenses with revenues. It balances costs to the time of use, as compared to the time when the cost was incurred. Generally, assets have long lives; therefore, their costs should be amortized over a long time (Periasamy, 2009, 56).

Typically, the full amount of a purchase must be recorded when the expense is incurred. The cash method of accounting advocates for recognizing the expense at the moment the payment occurs. On the other hand, the accrual method of accounting recognizes the expenses when they are incurred. This does not matter if the bill goes unpaid for some time. However, one ignores the accepted accounting principles (GAAP), the ratio of their income to expenses can be drastically off-centre. A solution to this case lies in the GAAP and IRS rules. These rules require certain costs to be capitalized so as to ensure recognition of costs and revenues happens in the same period (Smith, Raabe, & Maloney, 2010, 98).

Company’s capitalization of interest must be limited to construction projects. They may be meant for company’s use, real estate investments, or land improvements. The company must restrict capitalization of interest on money that it spent. This eliminates the capitalization on the total amount borrowed by the company. Capitalizing interest treats the interest as expenses over a period as a substitute of expensing the interest as a lump sum. Under FASB 34, interest on construction projects must be capitalised buy the concerned companies. In the process, the company must only capitalize the amount spent in the construction. In addition, the interest rate must be the lower between actual interest costs and avoidable interest. The capitalization of interest may only take place as the construction occurs. Per ASC 835-20-15-5(b), interest expenses are included in the inventory for assets meant for sale or leasing. These assets must also be constructed or otherwise made as discrete projects (for example real estate developments). Overhead costs normally included in a company’s inventory cost should not become non-inventory costs solely because of “industry practice.” A company should justify any change in its accounting for overhead costs (Davis, 2011, 257).

In the case of Herb Construction Company, the main issue is to decide whether to expense or capitalise the property taxes and interest during construction of the hotel. The accountant is also faced with the task of deciding the rate of interest that should be used to capitalize any interest costs. These decisions must be made with the consideration that there is no present buyer for the project is available. Property taxes paid for property under development for use or sale can be capitalized, but this must be treated as a period expense. Assets constructed for sale are considered qualifying assets for interest capitalization per IFRS standards.

The interest and the property taxes should be capitalised. Referring to IFRS standards (835-20-30-3 through 30-4), the accountant at Herb Construction Company must use a rate of interest “directly” associated with the project under construction. They could also use a weighted average of rates applicable to other debt that the company has incurred. These debts do not necessarily have to be associated to the project; it includes debts associated with other projects.

References

Davis, M. (2011). Accounting for Real Estate Transactions: A Guide For Public Accountants and Corporate Financial Professionals. San Fransisco: John Wiley & Sons.

Periasamy. (2009). Financial Management, 2E. New Delhi: Tata McGraw-Hill Education.

Smith, J. E., Raabe, W. A. & Maloney, D.M. (2010). South-western Federal Taxation 2011: Taxation of Business Entities. (14th ed.). New York: Cengage Learning.

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